From Treasure To Trash: Man Tosses Out Bitcoin Wallet On Hard Drive Worth $9 Million

Years ago, when renovating with friends, I took off my rings so that they wouldn't get damaged. In the flurry of clean-up, the rings got tossed into the trash. Despite going through bag after bag of garbage, we couldn't find them. I was not happy.

That has to be nothing compared to what James Howells is feeling. This summer, he threw out a computer hard drive containing more than $9 million in bitcoin. Yep, threw out. It is now almost impossible to find.

Bitcoins are digital currency. It doesn't rely on an exchange of paper and there is no centralized bank that records your transaction. Instead, bit coins are stored in a digital "wallet" which can be found on your computer.

If the concept of Bitcoin is still a bit cloudy, here's a brief video that explains it:

It's a pretty complicated system and there are some pitfalls, including the possibility of double-spending bitcoins (remember, there's no centralized transaction ledger). To prevent this, a bitcoin "reward" is given folks who engage in bitcoin mining, a technical process used to verify transactions.

That's what Howells did. As a tech geek, he mined bitcoins for years - long before you and I had even heard of them - which allowed him to store 7,500 bitcoins in his wallet.

The value of bitcoin isn't fixed. It fluctuates based on what the market is willing to pay. At the beginning of the year, bitcoin was valued at about $13. However, the price rose sharply on Friday, and finally settled around $1,155; to put that in perspective, gold prices were trading around $1,250 an ounce on the same day.

That means that the computer drive that Howells accidentally tossed out this summer in the midst of a cleaning spree was worth just under $9 million. And he made an unthinkable mistake for a tech geek: he had no back-up. Now, the drive, sits under the earth in a landfill somewhere, hidden under tons and tons of garbage.

Howells lives in the UK. You and I both know that if this had happened in the United States, that hard drive would likely never would have made it to the landfill and some trash picker, somewhere, would have been very happy about now.

But if Howells had lived in the United States, he also might have been able to claim a casualty loss deduction for his terrible turn of events. A casualty is, according to the Internal Revenue Service, "the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual." And there's a checklist:

A sudden event is one that is swift, not gradual or progressive (throwing out the hard drive was certainly swift).

An unexpected event is one that is ordinarily unanticipated and unintended (losing millions of dollars in bitcoin was certainly not on Howells' radar).

An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged (you don't see this every day!).

So far, so good, right?

Here's where it gets a little bit tricky. You can't usually take a deduction for lost or mislaid property. However, you can claim a deduction for accidental loss or disappearance of property if it results from an identifiable event that is sudden, unexpected, or unusual. Howells might lose out on this technicality since the actual loss of the property wasn't the result of an action that met the above-criteria. In other words, the entire transaction might qualify as sudden, unanticipated and atypical - but the action leading up to it (in Howells' case, cleaning house), would likely not.

It doesn't matter that Howells caused his own damage. The courts have found that you can still take the deduction even if you caused the damage, so long as you still meet the criteria. Consider the case of Justin M. Rohrs, a California resident, who successfully claimed a casualty loss deduction for his 2006 Ford F-350 pickup truck after he flipped his truck while legally drunk. Rohrs was initially denied the deduction by the IRS so he took them to court (representing himself). The judge ruled in Rohrs' favor, finding that "[w]hile petitioner’s decision to drive after drinking was negligent, that alone does not automatically rise to the level of gross negligence."

But let's assume it did meet the criteria. Even then, Howells' loss would be seriously limited. The loss for tax purposes wouldn't be, as you and I might assume, the entire $9 million. Rather it would be the lesser of the adjusted basis in the property (you can read more about basis here) before the casualty and the decrease in fair market value (FMV) of the property. The decrease in FMV for this purpose is considered the difference between the FMV immediately before the casualty and immediately after the casualty.

That creates two problems for Howells:

We don't know Howells' basis in the bitcoins but we can assume from the time span over which he accumulated the bitcoins - and the subsequent rise in value - that it was pretty limited.

The FMV "immediately" before the loss was the value in summer, when he tossed the computer, not this week when he discovered the loss. Ditto for the value "immediately" after. Bitcoin's value spiked in November. Over the summer, his actual loss was much smaller.

Howells didn't talk about any insurance - and likely didn't have any. But what if he had? It's not unusual to have homeowners or other insurance to cover the cost of the items in your home (though the chances of insuring an item in your home up to $9 million on mere speculation/hope/optimism are pretty slim). But if he had, and the reimbursement from insurance was more than his basis, there is a gain. If there's a gain, it is reportable and may be taxable. If the reimbursement was less than his basis, that amount would be subtracted before figuring the deduction.

The rules are a bit different for business or income-producing property. It's not clear whether Howells treated his property as business property, but if that were the case, the decrease in FMV would not be considered. It wouldn't matter to Howells since his basis remained low but for taxpayers, generally, your casualty loss for business purposes is figured by taking your adjusted basis and decreasing that amount by any salvage value (there is none here) and any reimbursement.

Assuming he had a reportable casualty loss, he would figure his deduction using either the personal property rules or the business property rules. The personal property rules would limit the deduction by taking the value of the loss and reducing it by $100. You reduce that amount again - this time by 10% of your adjusted gross income (AGI). These are known as the $100/10% rules. These rules don't apply to business property

So a quick example: Let's say the loss was found to be $10,000 (using the basis/FMV values as described above) and your AGI was $50,000. To figure the deduction, you would decrease that amount first by $100 ($10,000 - $100 = $9,900) and then further by 10% of your AGI ($9,900 - $5,000 = $4,900). Your actual deduction would be $4,900.

As to timing? Howells' lost the bitcoins and discovered his painful mistake all in the same year. However, had the loss occurred in one year and the discovery occurred in another year, the loss would have been properly claimed in the tax year in which the casualty occurred, not the year it was discovered (the rules are a bit different if the loss is due to a federally declared disaster).

It's a pretty amazing story. You have to feel for the guy who - but for a quick cleaning spree - was almost a millionaire. There are a lot of lessons to be learned:

Always back up your data. Always.

Keep good records to substantiate losses (and gains) on income-producing or other valuable property.

Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future, I enrolled in a tax course. I loved it. I signed up for another. Before I knew...